More Graham Bargains - International Flavors, McGraw-Edison, and Cheap Stocks

When you line two companies up side by side, truth becomes hard to ignore. One looks expensive. The other looks cheap. But which one actually makes you money? Harder question than most people think. Sometimes the cheap stock is cheap for a reason. Sometimes the expensive one earns its premium. Only way to find out is to dig into the numbers.

Four more comparisons, four different lessons about what really drives stock returns.

International Flavors & Fragrances vs. International Harvester

At the end of 1969, International Flavors & Fragrances – a specialty chemical company most people never heard of – had a higher total market valuation than International Harvester, one of the 30 giants in the Dow Jones Industrial Average. 747 million versus 710 million. Harvester had 17 times the capital and 27 times the annual sales. Three years earlier, Harvester’s net earnings alone exceeded Flavors’ entire revenue.

How? Profitability and growth.

Flavors posted a 14.3 percent net margin versus Harvester’s pathetic 2.6 percent. Return on equity: 19.7 percent versus 5.5 percent. Over ten years, Flavors grew earnings 326 percent; Harvester managed 39 percent. The market responded accordingly – Flavors at 55 times earnings, Harvester at 10.7 times.

Here is the interesting part: neither stock was a good buy. Flavors was brilliantly run – stuck to its core business, no acquisitions nonsense – but at 55 times earnings you are paying for decades of perfection. Harvester was cheap, but cheap for a reason. Over two billion in revenue and it could not earn a decent return. A massive enterprise generating inadequate profits is not a bargain; it is a value trap.

In the 1970 downturn, Harvester dropped 10 percent more from its already depressed level. Flavors fell 30 percent. Both eventually recovered, but Harvester soon slipped back. Neither delivered satisfactory long-term results. A low P/E means nothing if the business cannot grow. A great business at a terrible price is still a bad investment.

McGraw-Edison vs. McGraw-Hill

Two companies with nearly identical names, trading at roughly the same share price at the end of 1968. But underneath, completely different businesses and valuations.

McGraw-Edison made utility equipment and housewares. McGraw-Hill published books, magazines, and information services. Hill’s market cap was roughly double Edison’s – 962 million versus 527 million – despite Edison doing 50 percent more in sales with 25 percent higher net income.

The difference: Wall Street’s feverish love affair with publishing stocks in the late 1960s. McGraw-Hill rode that wave to 35 times earnings. Edison traded at a reasonable 15.5 times.

The problem? Hill’s earnings had already peaked. Per-share profits declined for two consecutive years. Investors were paying 35 times for shrinking profits. At 8 times book value, the stock implied nearly a billion in goodwill – the triumph of hope over experience.

Edison had strong fundamentals: 11.8 percent return on book value, 3.7 percent dividend yield, nearly 4 times current assets to liabilities. Boring but sensibly priced.

The aftermath was devastating for Hill. Earnings kept falling – from 1.13 to 1.02 to just 82 cents per share. In the May 1970 crash, the stock plunged to 10 dollars, less than one-fifth of its 1968 price. Recovery brought it only to 24 by mid-1971 – still 40 percent below where it started. Edison dropped to 22 but recovered fully to 41.50, above its pre-crash level.

Wall Street generates waves of enthusiasm for certain industries – publishing then, tech or AI now. These waves push prices beyond any rational level. When reality arrives, damage is severe. The boring, reasonably-priced company survives the storm and comes out whole.

National General Corp. vs. National Presto Industries

If the previous comparisons were about valuation, this one is about business complexity – specifically, what happens when a company tries to do everything at once.

National General Corporation was the classic late-1960s conglomerate. Its business description read like a fever dream: nationwide theater chain, motion picture and TV production, savings and loan association, book publishing, insurance, investment banking, records, music publishing, computerized services, real estate, and – I am not making this up – a 35 percent stake in Minnie Pearl’s Chicken System Inc. (later renamed Performance Systems Inc., because that sounds more serious).

National Presto Industries was the opposite. They started making pressure cookers, expanded into other kitchen appliances, and took on some ordnance contracts with the U.S. government. Simple, focused, understandable.

The financial comparison was almost comical. Presto had exactly 1,478,000 shares outstanding. That was it. National General had common stock, convertible preferred stock, three issues of warrants, a massive convertible bond issue, and nonconvertible bonds. Properly accounting for all the dilution, General’s true P/E was 69 times. Sixty-nine times earnings for a conglomerate that owned a fried chicken franchise.

Presto traded at 6.9 times earnings with zero debt. Current assets covered liabilities 3.4 times. Earnings grew 450 percent over five years. Return on equity: 21.4 percent versus General’s 4.5 percent.

The sequel was predictable. General continued diversifying, piling on debt. Then came write-offs of 72 million dollars, including the Minnie Pearl chicken disaster. Stock fell from 44 to 9 – down 85 percent. Presto declined to 21.50 in the 1970 crash but increased per-share earnings both years, marking a decade of uninterrupted profit growth. By late 1971, Presto was up 60 percent from its low.

Complexity in business structure is a warning sign. When a company needs warrants, convertible bonds, and layers of financial engineering to fund its empire-building, shareholders pay the price. Simple businesses with clean balance sheets tend not to blow up in your face.

Great Atlantic & Pacific Tea Company – When Mr. Market Loses His Mind

This is not a pair comparison but something more instructive: the full life cycle of a famous company, showing how the market can be catastrophically wrong in both directions.

A&P was the largest retailer in America. Shares traded as high as 494 in 1929. By 1938 they hit 36. At that price, total equity was worth 126 million. The company held 85 million in cash alone and 134 million in net current assets. You could buy the biggest retailer in the country for less than the cash on its balance sheet. The brand, stores, supply chain, all fixed assets – priced at zero.

Why? Three fears: potential chain store taxes, one year of declining profits, and a depressed market. First fear was groundless. Second and third were temporary. Within a year, the stock tripled to 117.50.

But here is the second act. By 1961, A&P traded at 30 times earnings – higher than the Dow’s ratio of 23. This implied brilliant growth. There was zero justification. The company was bigger but not better run, not more profitable.

The stock collapsed. Fell by half, then kept declining to 21.50 in 1970 and 18 in 1972, when A&P reported its first-ever quarterly loss. In 1938, this business was given away with no takers. In 1961, the public clamored to buy at absurd prices. Within a generation, the market swung from pricing A&P below liquidation value to pricing it like a growth stock.

The Pattern Across All Four Cases

The market consistently overpays for excitement and underpays for boring competence. Glamour stocks carry valuations requiring perfection. When perfection fails to arrive, losses are brutal.

But cheap stocks are not automatically good investments either. International Harvester was cheap but fundamentally broken. Real bargains are companies like National Presto and McGraw-Edison – solid businesses, clean balance sheets, steady growth, trading at reasonable multiples because nobody finds them interesting.

And as A&P shows, you have to keep watching. Today’s bargain can become tomorrow’s overvalued trap. The market is wrong often enough to create opportunities, but you must be paying attention to capitalize on them.

Key Takeaways

A low P/E ratio alone does not make something a bargain. International Harvester was cheap at 10.7 times earnings, but its inability to generate adequate returns made it a poor investment. Look at profitability, not just price.

Complexity is the enemy. National General’s conglomerate structure, layered capital instruments, and scatter-shot diversification were warning signs. Simple businesses with clean balance sheets are easier to analyze and less likely to collapse.

Wall Street enthusiasm is cyclical and dangerous. Publishing stocks in the 1960s, conglomerates, whatever the fad – when an entire sector trades at 30 to 70 times earnings, the smart money is heading for the exits.

The market gets it wrong in both directions. A&P was priced below its cash in 1938 and at 30 times earnings in 1961. Both prices were irrational. The investor who recognizes these extremes has a significant edge.

Check on your holdings regularly. You do not need to watch every day. But a thorough review once or twice a year lets you spot when a good business has deteriorated or when Mr. Market has lost his mind – in either direction.